Private money lending, as the name implies, means borrowing money from an individual investor. Real estate investors use private lenders to finance deals that either won’t qualify for a traditional loan or can’t wait the usual 30 days or so that a conventional mortgage loan needs for approval.
As Nasdaq accurately points out, private loans are particularly ideal for investors who want to buy a property that needs a lot of repairs.
Conventional financial institutions often refuse to grant mortgage loans for properties that have been vandalized or seriously damaged somehow.
On the other hand, private investors see the potential in a property that can be purchased cheaply, fixed for a reasonable price, and then resold for a tidy profit.
Additionally, a private money lender will have fewer requirements than other lenders.
More specifically, private investors focus on the potential profitability of the real estate purchase rather than the borrower’s financial history and credit score.
Furthermore, private money loans can be granted relatively fast, whereas a loan from a conventional lender may not be approved for up to 45 days.
There are a few disadvantages to obtaining private loans.
The first is that private lenders most often charge a higher interest rate than the average bank loan.
Private lending rates hover around 15%; however, you may be required to pay up to 20%.
This is particularly true if you have poor credit and/or the purchase of the property is risky in some way.
Lenders also add “points” to the loan, creating an additional expense for borrowers to cover.
Another disadvantage is that, unlike banks, raising private money won’t allow you to pay off a loan over a 30-year period.
You can expect to be required to pay the loan back within six to twelve months, although some more-lenient lenders, especially those you may be related to, may give you a couple of years.
One more thing to keep in mind: you will most likely have to use the property as collateral for the money financed from a private money lender.
This means doing your due diligence to ensure a deal’s framework (and potential) meets your criteria.
The good news is these disadvantages do not pose a hindrance to your real estate investment plans if you have done your research before pitching an investment deal.
If you know the property is a good buy and are reasonably sure you can fix it up and sell it at a profit within a reasonable amount of time, the strict repayment time frame shouldn’t cause alarm.
Real estate investors who make money by purchasing low-cost properties in need of fixing up, making value-boosting repairs and renovations and then flipping the homes for profit may utilize hard money loans.
Because these projects typically happen fairly quickly, professional flippers often prefer faster forms of financing. Additionally, because house flippers generally try to sell the home within a short period of time – typically less than a year – they don’t need a lengthy loan term you’d get with a traditional mortgage.
Those who want to invest in rental property but don’t qualify for traditional financing might seek out a hard money loan to pay for their investment.
This method can be useful if you can’t get approved for a traditional loan due to credit history or if you need more money than a traditional lender will let you borrow.
Similarly, a business owner might use a hard money loan to fund the purchase of commercial real estate if they’re unable to secure traditional financing. Hard money loans can be useful for entrepreneurs purchasing a unique property that doesn’t qualify for conventional financing.
The same may be true for those who find traditional commercial loan limits insufficient for their needs.
Think of it this way: private lending involves borrowing money from people with the means to invest capital in your venture (there’s no financial institution backing this investor).
A good example of a private money lender would be a friend or family member — anybody in your inner circle — or an individual investor who was intrigued by your proposal and wants to be a part of your investment.
Hard money lending is something that lives between private money lending and conventional bank financing.
Though hard money lending doesn’t require the usual hoops to jump through that conventional financing does, hard money lenders are semi-institutional and do have their own set of established criteria.
Both types of lending should be part of an investor’s financing toolbox.